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Income-Induced Expenditure Switching

Listed author(s):
  • Bems, Rudolfs
  • di Giovanni, Julian

This paper shows that an income effect can drive expenditure switching between domestic and foreign goods. We use a unique Latvian scanner-level dataset for food and beverages, covering the 2008-09 financial crisis, to study (i) relative price movements, and (ii) expenditure switching between domestic and imported goods. We document several empirical findings. First, imports contracted by 26%, with expenditure switching accounting for one third of the fall, while the relative price of foreign goods viz. the food CPI increased by 4.4% during the crisis. Second, the majority of the switching took place between items within narrowly defined product groups, while the relative price adjustment was across product groups. This puzzling asymmetry in expenditure and price adjustments, combined with a finding that consumers substituted towards lower unit value domestic items during the crisis, motivate us to model non-homothetic consumer demand. Over the crisis period, the estimated model explains eighty percent of the observed expenditure switching, which was driven almost entirely by an income effect.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9887.

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Date of creation: Mar 2014
Handle: RePEc:cpr:ceprdp:9887
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  1. Jose Manuel Campa & Linda S. Goldberg, 2006. "Distribution margins, imported inputs, and the sensitivity of the CPI to exchange rates," Staff Reports 247, Federal Reserve Bank of New York.
  2. Olivier Coibion & Yuriy Gorodnichenko & Gee Hee Hong, 2013. "The Cyclicality of Sales, Regular and Effective Prices: Business Cycle and Policy Implications," Staff Working Papers 13-1, Bank of Canada.
  3. Paul Krugman, 1988. "Differences In Income Elasticities and Trends in Real Exchange Rates," NBER Working Papers 2761, National Bureau of Economic Research, Inc.
  4. Berka, Martin & Devereux, Michael B., 2011. "What determines European real exchange rates?," Working Paper Series 1687, Victoria University of Wellington, School of Economics and Finance.
  5. repec:bin:bpeajo:v:47:y:2013:i:2013-02:p:325-388 is not listed on IDEAS
  6. Kehoe, Timothy J. & Ruhl, Kim J., 2009. "Sudden stops, sectoral reallocations, and the real exchange rate," Journal of Development Economics, Elsevier, vol. 89(2), pages 235-249, July.
  7. Piero Esposito & Claudio Vicarelli, 2011. "Explaining the Performance of Italian Exports during the Crisis: (Medium) Quality Matters," Working Papers LuissLab 11954, Dipartimento di Economia e Finanza, LUISS Guido Carli.
  8. Ravn, Morten O. & Schmitt-Grohé, Stephanie & Uribe, Martín, 2008. "Macroeconomics Of Subsistence Points," Macroeconomic Dynamics, Cambridge University Press, vol. 12(S1), pages 136-147, April.
  9. Antoine Berthou & Charlotte Emlinger, 2010. "Crises and the Collapse of World Trade: the Shift to Lower Quality," Working Papers 2010-07, CEPII research center.
  10. Blackorby, Charles & Boyce, Richard & Russell, R Robert, 1978. "Estimation of Demand Systems Generated by the Gorman Polar Form: A Generalization of the S-Branch Utility Tree," Econometrica, Econometric Society, vol. 46(2), pages 345-363, March.
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